Settling disputes with members of the Management Board of a German stock corporation: Pitfalls and contractual options

Introduction

Board members of German stock corporations are increasingly subject to claims for breach of duty. A swift and amicable solution of such disputes will usually be the preferred choice of the parties. German mandatory law, however, imposes certain restrictions on the part of the company in this regard. Non-compliance with such restrictions will render any settlement void.

Over the years, German courts have repeatedly emphasized the Supervisory Board’s duty to pursue the company’s claims against board members for a breach of duty and that, if such claims are not enforced, the members of the Supervisory Board may themselves be liable. This, as well as ever stricter compliance requirements and increasing public interest, has led to board members being increasingly subjected to damages claims. Usually, the parties will try to solve such disputes out of court first, to avoid time-consuming and costly public court proceedings. Even if these efforts fail and the matter becomes contentious, a German court is required by law to consider, together with the parties, an amicable solution of the dispute at any stage of the proceedings. In either case, the parties to the dispute must ensure that such settlement observes the strict limitations of the German Stock Corporation Act (SCA) which apply to the company to avoid such agreement being invalid.

The mandatory legal framework of the SCA

According to section 93(4) SCA the company may only waive or settle any liability claim against a (former) board member if the following requirements are met:

• three years have passed since the claim arose (unless the board member is insolvent and the settlement prevents the initiation of insolvency proceedings or the claim is the subject of an insolvency plan).
• the general meeting approved the settlement or waiver. A simple majority vote is usually sufficient (unless the company’s articles of association require a larger majority).
• there is no objection to the settlement or waiver raised in the general meeting by shareholders whose aggregate share capital amounts to one tenth of the company’s overall share capital.

If any of these requirements are not met, the entire settlement is void.

Strict interpretation of the SCA’s limitations

The overriding aim of these mandatory limitations is to safeguard the company’s assets. The three-year period prevents a premature settlement, i.e. at a point in time when it is not yet possible to fully assess the effects of the board member’s breach of duty. Moreover, the required approval of the general meeting precludes any collusion between the relevant board member and the Supervisory Board (which represents the company in these disputes) to the company’s detriment. Apart from that, the restrictions also protect the interests of the minority shareholders.

To achieve this, the requirements in section 93(4) SCA are subject to strict interpretation. For example, the three-year period cannot be shortened even if the company’s investigations of the board member’s breach of duty and the corresponding damages have been completed before the period expired. Similarly, any settlement that has been concluded within this period does not become effective even if the general meeting approves the agreement afterwards. On the contrary, the settlement between the company and the board member must be agreed, subject to the general meeting’s approval, after the three year period has passed. In the same vein, the general meeting must explicitly resolve on the settlement or waiver; the mere discharge of a board member does not suffice in this regard.

Moreover, in order to prevent a circumvention of section 93(4) SCA, these requirements do not only apply to waivers and settlements but also to similar arrangements between the company and the board member that have the same effect, such as any agreement not to assert claims (pactum de non petendo) or moratoria of any kind.

The Supervisory Board’s principal courses of action with regard to quantified claims of the company

If the company’s claim is not pending in court, the Supervisory Board, on behalf of the company, may only reach a general understanding with the board member on the terms of a potential settlement. Once the three-year period expired, the agreement can be formally concluded subject to the approval of the general meeting. In cases where the dispute is already pending, the court will stay the proceedings upon the request of both parties, if the settlement discussions between the parties are promising. Such suspension of the proceedings may last for several years due to the mandatory three-year period and depending on the timing of the general meeting. It is therefore important that the company and the board member agree on a respective waiver of the statutory limitation period to avoid any uncertainties in this regard. If the general meeting approves the settlement, the legal action can be withdrawn which will, again, reduce the court and legal fees.

Contractual structures to settle unknown and/or unquantified claims of the company

There are, however, scenarios in which a settlement with the board member will only be reached if the company agrees to waive generally all of its claims, even though then unknown. Typical examples are the negotiation of a termination agreement with a board member or a pending dispute on the board member’s removal from office. In all of these cases both the company and the board member will aim to settle their relationship in its entirety and thus require that any agreement includes a comprehensive mutual waiver with regard to potential future claims. While the board member may release the company from any such liability, the company is bound by the limitations stipulated in section 93(4) SCA. Given the practical need for a settlement in these scenarios, the following contractual options are typically considered to take regard of the board member’s interest in a waiver of liability and the requirements of section 93(4) SCA:

• First, a third party (e.g. the company’s majority shareholder) accedes to the settlement agreement and indemnifies the board member from any (potential) liability claims the company may have against it in the future. Such an agreement is considered to be in line with section 93(4) SCA since the board member’s liability towards the company remains. However, this option is only viable if a majority shareholder is prepared to step in (which may not always be the case). Apart from that, a majority shareholder may only be prepared to provide such indemnity if there are no circumstances that actually point to a liability claim against the board member or at least to limit the scope of indemnification, e.g. exclude liability claims based on intent or based on particular circumstances. A Directors and Officers Liability Policy (D&O Policy) may provide further comfort to the third party in this regard. A D&O Policy often covers a breach of duty by board members based on gross negligence or, as the case may be, conditional intent (dolus eventualis) and may also extend to former board members. The board member can therefore agree to assign its coverage claim against the insurer to the third party in return for the indemnity. In this case, it is, however, crucial that the company ensures adequate coverage in the future since D&O Policies, which are renewed on an annual basis, only respond to liability claims that have been raised by the company against the board member within the respective policy period (claims-made principle).
• Second, it is sometimes suggested that the company may also consider assigning its future liability claims to a third party which, again, waives its claim against the board member. It is, however, submitted that this constitutes an impermissible circumvention of section 93(4) SCA, unless the company is fully compensated by the third party for the assignment of the claim. It is therefore considered that this option is not viable since the required compensation presumes that the claim can be fully quantified which, again, is not the case here.

Comment

Any settlement of disputes with board members must take full account of the requirements stipulated in section 93(4) SCA. Companies will particularly perceive the mandatory three-year period to constitute a significant obstacle to the resolution of any dispute with a board member. Moreover, the Supervisory Board must take care when negotiating the terms of the settlement since the general meeting will only grant its approval if the agreement takes full account of the factual and legal uncertainties of the dispute. Finally, while section 93(4) SCA applies to any claims of the company, an indemnification of the board member by a third party may be a viable option to facilitate an amicable solution with a view to potential future claims.